When commercial real estate finally hits bottom — and that could be at least another year away — it will exist in a much colder world than the fevered run-up.

STORY BY TODD MURPHY // PHOTOS BY ADAM BACHER

Portland developer Tom Moyer started construction on Park Avenue West, which was to include retail, offices and condos, with his own money. But work on the building was halted in April 2009 when, in the midst of the credit crunch, Moyer couldn’t get a loan to finish construction.

The rusting rebar at the stalled Park Avenue West construction site in the middle of downtown Portland tells only part of the story.

To really get a sense of the depths of the Portland Metro area’s commercial real estate economy, you have to move beyond Tom Moyer’s problems in getting a construction loan to continue work on his office tower. You need to drive west of the city along the Sunset Corridor on Highway 26. Soon, the for-sale and for-lease billboards sprout like weeds in front of sleek, glass-fronted, and empty, office buildings. Weeds that have been around for a while. Weeds that likely will be around for a while.

“Take my empty building — please,” the signs seem to be saying. In this economy, you might be able to buy it for half of what somebody paid for it two or three years ago.

The Moody’s/REAL Commercial Property Price Indices show prices of commercial property were down nationally 40% from the peak in the first quarter of 2007 to the third quarter of 2009. (Prices declined less precipitously in the West; by the third quarter of 2009, they were down 26% from the peak in the first quarter of 2008.)

Moody’s doesn’t specifically track the Portland region’s numbers, but some recent sales point to the depth of the decline.

A company affiliated with Portland’s Felton Properties recently paid $27 million for the AmberGlen Business Center complex in Hillsboro, less than half of the $68 million that the eight buildings sold for in 2007. And Portland investment firm American Pacific International Capital in December bought the 19 office floors of the downtown KOIN Tower for an estimated $57 million, a bit more than half the $108 million that the California Public Employees’ Retirement System paid for the floors in 2007.

And when things finally hit bottom in the commercial real estate world — not until 2011, maybe later, experts say — commercial real estate will exist in a very different world from the bubbled world of 2004 to 2007.

There will be much less building “on spec” — developers building properties without knowing who might want to rent or buy them. And there won’t be the financing gifts of the past, where community banks gave loans to developers and building owners who had little if any of their own equity in the deal.

In fact, the entire financing structure of many commercial real estate deals may change. Building owners will go to banks for a not-especially-large portion of the financing and have to put up their own cash or go to other sources like private equity funds for the rest.

The community banks that survive for the next commercial real estate world — and some won’t, experts say, because of unwise loans they made in the years leading up to 2008 — will be lending on a much more careful and traditional basis. They’ll be giving loans of maybe only 60% or 70% of the now-lowered value of the property.

For some traditional titans in commercial real estate and some new cash-rich entrants into the industry, that will work out OK. Large players in the industry and others, including private equity funds, have been amassing cash during the tumult of the last year or more.

“And they’re looking for opportunities,” says Mike Paul, former CEO of The Commerce Bank of Oregon, who now is a partner in a firm helping financial institutions dispose of their non-performing assets: foreclosed properties.

“I think you’re going to see some buyers with equity. They’re going to come into the game...and they’re going to buy properties at deep discounts,” says Jeff Borlaug, a vice president at Portland’s NAI Norris Beggs & Simpson and president of the Portland region’s Commercial Association of Realtors.

Paul suggests that the new commercial real estate world, with the traditional banks being reluctant to lend very much on any property, will leave an opening for those new entities to be part of deals. The private equity firms and others, looking to place cash in a distressed market, will provide some less-traditional financing that will make up a part of the deals. The firms will do it as more expensive lenders, or in return for equity in the properties.

The private entities might provide another 10% to 20% of the value of the property, with the owner providing the final 10% to 20%.

Shorenstein Realty Services LP breathed a sigh of relief in February when the federal government announced it would lease 70% of the 350,000 square feet in the company’s new First & Main building in Portland. Federal agencies displaced by the renovation of the Edith Green-Wendell Wyatt federal office building downtown will move to the new building.

What will this mean for the other side of commercial real estate — the people and companies that actually want to rent space?

Aside from how they’ve been crunched by the overall economy, they’ve had it very nice over the last year or more, as frantic building owners have been willing to do just about anything to attract tenants or keep current ones satisfied.

Some are giving a month or two of free rent; many are willing to sign tenants into shorter leases than they traditionally would. H&M, the Swedish clothing retailer, signed a four-year lease last December for space in downtown Portland’s Pioneer Place mall — rather than signing a more traditional 10- or 15-year lease.

But Paul believes the new financing structure that will be more common in commercial real estate by 2012 “probably means higher costs. It’ll put pressure on rents. It’ll put pressure on the economics.”

Not that there’s not enough pressure on the economics these days.

Commercial office vacancy rates in the fourth quarter of 2009 were nearing 30% in the suburbs around Portland, in some places the highest vacancy rates ever.

The Sunset Corridor along Highway 26 west of Portland had an overall commercial real estate vacancy rate of 28% in the fourth quarter of 2009. The area around Tualatin and Wilsonville had a vacancy rate of 28.3%. The area encompassing Washington Square Mall and the Kruse Way area in Lake Oswego had a vacancy rate of 21%.

“And it will probably even get worse,” says David Hill, vice president for the investment group Grubb & Ellis’ Portland office.

“I think 2010 will be a terrible year for commercial real estate,” says economist John Mitchell, former chief economist for U.S. Bancorp and now an economics consultant. “You have falling employment; you’ve got falling rents; you’ve got falling values. And in order to fix that, it’s going to take time.”

Time is something that some building owners don’t have. Possibly more importantly, it is also something that some of the state’s community banks — which loaned building owners their financing at the peak of the market — don’t have.

In the real estate spike of the last 10 or 15 years, community banks became the primary lenders for most commercial real estate: office and industrial buildings, retail space and apartments. Five community banks in Oregon now have more than 70% of their total loan portfolio in commercial real estate, according to their most recent filings with the Federal Deposit Insurance Corporation. They are Clackamas County Bank of Sandy, Lewis & Clark Bank of Oregon City, MBank of Gresham, Willamette Valley Bank of Salem and PremierWest Bank of Medford, whose stock recently fell below $1 and has been warned that it faces delisting from NASDAQ.

When prices of real estate were continually rising and vacancies were low, things were great for community banks. “They’ve made a pretty good living on real estate financing,” Paul says.

But then came the bust.

Now, as the job market remains dormant, the vacancies remain. As vacancy rates stay high, building values plummet. As building values plummet, many owners owe more on their loans than the properties are worth. And community banks with the loans on their books have lost billions of dollars in asset value.

Many in the industry say some building owners without deep pockets are finding it difficult to make their loan payments or sell their buildings. (No one would name names.)

And they would be in greater danger of losing the buildings to their lenders if their lenders had any idea what to do with them.

“They’ve got a real issue,” Joe Voboril, a longtime commercial real estate lawyer for Portland’s Tonkon Torp law firm, says of the banks. “Even if the bank takes it back, what are they going to do with it? It may be worth a fraction of what they loaned.”

Throughout 2009 and early 2010, the banks have been “nursing loans, extending them, modifying them, to avoid declaring defaults,” Voboril says. “And praying to God that things will turn and they’ll eventually get paid.”

About 28% of the commercial office space in the Sunset Corridor along U.S. Highway 26 west of Portland was vacant in the fourth quarter of 2009 — more than 1.1 million square feet of office space.

Some of the community banks with commercial real estate loans on their books may not have time. Nine Oregon community banks have 5% or more of their total loans considered noncurrent, meaning payments on those loans are at least 90 days past due, according to their most recent reports filed with the FDIC. One of those is Albina Community Bank, with 7.61% of its loans considered noncurrent as of Dec. 31 and which just last month was ordered by state and federal regulators to raise its capital levels and reduce its noncurrent loans. With that “consent order” from regulators, Albina became the seventh Oregon community bank operating under cease and desist orders or consent agreements. This generally requires banks to raise new capital or improve their loan portfolio quality, or both. The other six are MBank, Home Valley Bank, Bank of the Cascades, Columbia Community Bank, West Coast Bank and Liberty Bank.

The delinquency rate in the Portland area for commercial loans hit 4.8% in the fourth quarter of 2009, six times the rate for the fourth quarter of 2007, according to Foresight Analytics, an Oakland, Calif., research firm.

“In the last couple of quarters, we’ve started to see some evidence of banks starting to foreclose on the commercial stuff,” says Joey Warmenhoven, a community-banking analyst for McAdams Wright Ragen, a Seattle investment bank.

Telling examples include Portland commercial developer John Beardsley last October filing for bankruptcy four days before his lender, Telesis Community Credit Union, was set to foreclose on some of his properties. And Felton Properties got such a great deal on AmberGlen because it was buying the property from the former owner’s lender, which had foreclosed on the property.

If regulators force the community banks to raise capital to compensate for the decreasing value of their real estate, some will not survive 2010.

“If commercial real estate is just a complete mess, it’s going to wipe out a lot of banks,” says Warmenhoven.

Still, Richard Renken, program manager for banks and trusts for the Oregon Division of Finance and Corporate Securities, says traditional commercial real estate has not been as problematic for the banks as the loans they made to residential housing developers to buy land to build subdivisions. Community banks suffered a slew of defaults on those loans in 2009.

“I do not believe that the income property [in commercial real estate] will rise to the high level of defaults we saw on the residential side,” Renken says.

There are glimmers of hope in all of this.

Late last year, an influential annual survey of real estate experts conducted by the Urban Land Institute and PricewaterhouseCoopers rated the Portland area as the nation’s No. 16 region for commercial real estate investment, in large part because its urban growth boundary prevented massive overdevelopment.

And early this year, a Grubb & Ellis annual survey listed Portland in the top 10 among local markets in terms of “long-term investment potential” in each of the four categories of commercial real estate: office, industrial, retail and apartments. The survey listed Portland’s investment potential as fourth-strongest in the nation in the office category, No. 8 in apartments and No. 9 in industrial and retail.

“Toward the end of summer in ’09, we got busy — people started to tour spaces,” he says.

And that underlines the glass-is-half-full side of the commercial real estate problem: It’s good to be a tenant, or potential tenant. At least for the near future.

“It’s sunk in to developers and landlords that this could be a prolonged downturn,” says Sweitzer. “And it’s better to make a deal today — give some free rent, lower the rent a little bit — than it is to wait it out.”

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